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TalkingPoints: Tracking Covered Calls in the Australian Stock Market

A Deep Dive into Sustainability Sector Indices

TalkingPoints: S&P Dividend Monarchs Index

Dividend Strategy with Quality Yields – The Dow Jones Dividend 100 Indices

Providing Index Solutions to EU SFDR Article 9 Requirements with the S&P Paris-Aligned Indices

TalkingPoints: Tracking Covered Calls in the Australian Stock Market

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Parth Shah

Director, Derivative Indices

S&P Dow Jones Indices

The term covered call refers to an option strategy in which the investor selling call options owns an equivalent amount of the underlying security. To execute a covered call, the investor holds an underlying position on individual stock(s) or an index-like position. In addition, the investor seeks to supplement their return by systematically selling calls against their long position(s) and collecting option premium.

A covered call strategy essentially is intended to transform a “growth” position (i.e., a long stock) to a “growth and income” play. The potential for larger gains longer term is in effect swapped out for immediate income. A systematic covered call strategy may contribute to consistent income generation especially during low volatility periods.

1. What is the S&P/ASX Buywrite Index

The S&P/ASX Buywrite Index is designed to measure the performance of a theoretical covered call strategy that is rebalanced quarterly and comprises a short position in the at-the-money (ATM) call option on the S&P/ASX 200 and a long position on the S&P/ASX 200.

2. What is a covered call strategy, and how does it work?

A covered call (or buy-write) strategy aims to generate income and mitigate loss, particularly in bear market conditions. Specifically, this strategy involves selling a call option against an underlying asset that is already owned by the option writer. If the asset’s market price exceeds the contract’s strike price at expiration, the call writer would be obligated to sell the underlying asset at the option strike price to the option buyer. If the strike price is not met, the option writer maintains control of the asset. Either way, the option writer generates income from selling the call contract — this is known as the “option premium.”

3. What are the potential advantages of this type of strategy?

The main potential benefit of this strategy is the income generation from accumulating call option premiums. One factor that affects these premiums is the “option moneyness” — that is whether the option contract is “in the money” (ITM), “out of the money” (OTM) or “at the money” (ATM). An OTM call has a strike price that is above the current market price. An ATM call has a strike price that is equal to the current market price of the asset — this generates a higher premium, as there is a greater chance that the option will be exercised at this price. These premiums offer supplemental income to traditional sources like dividends and fixed income. This income can be distributed or reinvested into the underlying asset to mitigate against losses in a bear market.

4. What are the potential disadvantages of this strategy?

A drawback of the covered call strategy occurs if a call option is ITM, in which case the option writer would miss out on any gains that the asset may achieve beyond the strike. The option seller would be forced to sell the asset at this lower price, therefore capping the asset’s growth potential. This often occurs during bull markets, as the market price of the underlying asset increases above the option strike price. A long-term covered call strategy may help make up for this by offering income that can be used to reinvest into the asset.

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A Deep Dive into Sustainability Sector Indices

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Stephanie Rowton

Director, Head of Sustainability Indices EMEA

S&P Dow Jones Indices

Introduction

Investing in sectors has grown dramatically over recent years, as investors look to express a view on the broader economic conditions while maintaining diversification and mitigating single-stock risk.  Additionally, there has been an increase in market participants looking to allocate strategically to sustainability.  Many are starting to look for ways to integrate sustainability values into their investments through more precise tools such as sector allocation. S&P Dow Jones Indices (S&P DJI) has introduced a suite of sustainability sector indices, including the S&P ESG Enhanced Sector Indices and S&P Sustainability Enhanced Sector Indices, to meet this need.  By utilizing S&P DJI ESG Scores, business activity exclusions, UN Global Compact (UNGC) exclusions, daily controversy monitoring and S&P Global Trucost carbon data, our sustainability sector indices have historically offered a meaningful improvement in ESG profile and carbon emissions profile against their non-ESG underlying index.

A Deep Dive into Sustainability Sector Indices: Exhibit 1

S&P DJI ESG Scores

The S&P DJI ESG Scores are derived from over 22 years of detailed sustainability data from the industry leading sustainability assessment, the S&P Global Corporate Sustainability Assessment (CSA).  The CSA is an annual evaluation of companies’ sustainability practices.  A key feature of the CSA is that, through optional active participation in the assessment, companies can disclose additional details to our analysts beyond what is publicly available.  This engagement opportunity, coupled with the granularity of the CSA, enables S&P Global to provide a holistic and complete view of a company’s sustainability profile; differentiating the S&P DJI ESG Scores from other ESG scores that rely solely on data from public sources.  A company’s active participation in the CSA allows S&P Global to collect between 600 and 1,000 data points per company, which feed into the S&P DJI ESG Scores (see Exhibit 2).

A Deep Dive into Sustainability Sector Indices: Exhibit 2

The CSA and the derived S&P DJI ESG Scores are driven by materiality analysis considering both financial materiality and how sustainability criteria present a significant impact on society or the environment.  Material sustainability criteria have the potential to significantly influence an entity's business value drivers, including, for example, business operations, cash flows, legal or regulatory liabilities and access to capital.  Furthermore, sustainability criteria have the capability to significantly improve or undermine an entity’s reputation and relationships with key stakeholders and society, including the environment.  Therefore, companies are assessed according to the sustainability issues that are weighted according to the magnitude and likelihood of their impact on enterprise value creation and external stakeholders, including the economy, the environment and people.  Collecting and scoring data according to these factors ensures that companies have been measured based on the sustainability issues that are most relevant to them.  The examples in Exhibit 3 show how weights assigned to issues in different industries can vary greatly.

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TalkingPoints: S&P Dividend Monarchs Index

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Jason Ye

Director, Factors and Thematics Indices

S&P Dow Jones Indices

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Izzy Wang

Senior Analyst, Factors and Dividends

S&P Dow Jones Indices

The S&P Dividend Monarchs Index is designed to track long-standing companies in the U.S. market that have consecutively increased dividends for at least 50 years. The S&P Dividend Monarchs Index constituents have endured more than a half a century’s market turbulence and demonstrated resilience in dividend growth and stock performance. As a new generation from the flagship S&P Dividend Aristocrats® Index Series, the S&P Dividend Monarchs Index constituents push the threshold of being an elite group of dividend-paying companies to the next level.

  1. Why was the index introduced?

As a leading dividend index provider, S&P Dow Jones Indices pioneered in developing a dividend growth strategy. Since the early 1980s, our research team started to monitor U.S. companies that increased dividends for at least 10 years. In the early 2000s, as more companies were able to consecutively increase dividend payments, we raised the observation list threshold to 25 years, which then became the initial basket of “U.S. Dividend Aristocrats.” In May 2005, the S&P 500® Dividend Aristocrats was officially launched, which soon became one of the most well-recognized dividend growth strategies in the market. Since then, we have extended the S&P Dividend Aristocrats Series to cover the mid- and small-cap universes and other global markets. As of April 2023, more than USD 40 billion of ETF assets were tracking the S&P Dividend Aristocrats Indices.

Fast forward to 2023, almost 20 years since the launch of the S&P 500 Dividend Aristocrats, we found that the number of companies in the index had grown from 57 to 66.  In the past five years, we have noticed a growing number of companies consecutively increasing dividends for more than 50 years (see Exhibit 1), these companies exist not only in the large cap (the S&P 500) but also in the mid- and small-cap universes (the S&P MidCap 400® and the S&P SmallCap 600®). In January 2023, more than 30 companies from the S&P Composite 1500 had increased their dividends for at least 50 years. This created a diversified basket of stocks for a new index concept, prompting the introduction of the S&P Dividend Monarchs Index.

Talking Points: S&P Dividend Monarchs Index: Exhibit 1

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Dividend Strategy with Quality Yields – The Dow Jones Dividend 100 Indices

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Izzy Wang

Senior Analyst, Factors and Dividends

S&P Dow Jones Indices

INTRODUCTION

Dividend-paying stocks have been in focus over the past decade—assets tracking passively managed dividend products have grown substantially on the back of demand for yield and equity participation.  However, high-yielding companies without strong financial stability may be prone to dividend cuts under the pressure from global economic uncertainties and rising interest rates.  Thus, an investment strategy searching for high yield should consider focusing on quality as well.

Among the different kinds of income-focused equity indices in the market, the Dow Jones Dividend 100 Index Series takes a unique approach.  It seeks to track the performance of 100 high-dividend-yielding stocks in each market covered that have a record of consistently paying dividends, selected for solid fundamental strength.

S&P DJI launched the Dow Jones U.S. Dividend 100 Index in 2011.  In 2021, we expanded the index series to international markets with the launch of the Dow Jones International Dividend 100 Index.  This paper investigates the following potential benefits of the Dow Jones Dividend 100 Indices.

  • Sustainable dividends with financial quality. The indices not only seek to track stocks with consistent dividend payouts, but they also apply a quality screen for the sustainability of yields.  They seek to achieve “quality yields” by requiring stocks to have paid dividends for a minimum of 10 consecutive years, and by ranking stocks by a composite score calculated from the cash-flow-to-total-debt ratio, return on equity (ROE), dividend yield and five-year dividend growth rate.  In addition to the fundamental annual rebalancing, starting from July 2018, S&P DJI introduced a monthly dividend review as an ongoing maintenance to ensure dividend sustainability.  Every month, stocks that have canceled their dividends will be removed from the indices.
  • Dividend growth against future rising rates. A focus on dividend growth in an environment where market participants are concerned about rising rates may be important.  Typically, high-yield equity strategies are biased toward rate-sensitive sectors, which tend to pay out higher yields because of the leverage that they can take on (mainly because of mature business models; e.g., Utilities).  Such entities are exposed when rates rise.  Selection based on dividend growth helps to ensure that firms that can develop their business and increase their payouts are favored in the selection process.  Such businesses are often well-managed companies, from both capital structure and operational perspectives.
  • Investability. Differentiating the Dow Jones Dividend 100 Indices from other dividend strategies are their strict size and liquidity screens and their weighting method, which is based on a modified market capitalization approach.  These attributes were chosen with the goal of increasing index investability in terms of liquidity, capacity and turnover.  Size and liquidity screens could help to reduce the influence of smaller and more distressed stocks on the portfolio, leading to a liquid basket of constituents.  A weighting method based on modified market capitalization could not only help maximize the index capacity, but it also has potential to lead to a lower turnover than alternatively weighted income indices, that weight constituents primarily by yield or total dividends.

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Providing Index Solutions to EU SFDR Article 9 Requirements with the S&P Paris-Aligned Indices

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Kieran Trevor

Analyst, ESG Research & Design

S&P Dow Jones Indices

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Barbara Velado

Senior Analyst, Research & Design ESG Indices

S&P Dow Jones Indices

Executive Summary

Guidance published by the European Supervisory Authorities (ESAs) in May 2023, has clarified the position for active and passive Article 9 financial products using an EU Paris-aligned Benchmark (PAB) or an EU Climate Transition Benchmark (CTB).  The pertinent regulatory guidance in the Q&As relating to Article 9 financial products was twofold.

  • On Nov. 17, 2022, the ESAs clarified that when an Article 9 financial product has sustainable investment as its objective, the designated index that has been selected as a reference benchmark cannot be a broad market index. As of March 2023, there were nearly 900 Article 9 funds. If these funds are benchmarked against a broad market-cap-weighted index, they will need to take action and identify an “objective-aligned” benchmark (9.1) or a PAB (9.3), if they are to maintain their Article 9 status.

  • On May 17, 2023, the ESAs stated that passive financial products that track a PAB or CTB are deemed to have a sustainable investment objective; therefore, such financial products can be categorized as Article 9.

The S&P PACTTM Indices (S&P Paris-Aligned & Climate Transition Indices) offer a broad, diversified, beta-like exposure.  Importantly, the indices seek to eliminate exposure to significant fossil-fuel-based energy (as defined by the EU’s minimum standards for PABs in the Low Carbon Benchmark Regulation (LCBR)), overcoming the “tracking error lock” to fossil fuel energy and broad benchmarks if the broad market does not transition.  In order to comply with the LCBR, the S&P Paris-Aligned Indices aim to incorporate the following climate objectives:

  • To underweight or remove the Energy sector;
  • To have defined net zero pathways;
  • To reduce forward-looking transition and physical risks; and
  • To address climate objectives and get ahead of emerging sustainability trends.

A similar framework is also utilized in our iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG Index, with appropriate features for fixed income indices.

This paper provides an overview of the Article 9 fund market as it stands, insight into how the S&P Paris-Aligned Indices work and the exposures they exhibit from both climate and more traditional risk factor perspectives.

Article 9: Defined Inflows and Organic Growth

“Dark green” Article 9 funds have fared well relative to their “light green” Article 8 counterparts with respect to assets under management and growth.  In 2022, Article 8 funds saw net outflows over the year, while Article 9 funds saw consistent inflows for each quarter, with EUR 5.1 billion of inflows in Q4 alone. When considering growth of flows relative to assets, Article 9 funds have seen greater growth compared with Article 8 funds month-over-month since the introduction of the Sustainable Finance Disclosure Regulation (SFDR) in March 2021.  Combined, these seem to evidence investor preference for the dark green Article 9 products over their Article 8 counterparts.

As of March 2023, there were 887 European Article 9 funds (3.6% of all funds by count), down from 1,080 in September 2022, largely due to the number of downgrades to Article 8 observed in Q4 2022.

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